HU 300

Engineering Economics

July-Dec 2016

Recap- Engineering Economic Process

with Application

Your friend bought an apartment building for $100,000.

She spent $10,000 of her own money, got a
mortgage for the remaining $90,000.
Annual
mortgage payment to the bank is $10,500. Expected
annual maintenance of the apartment building is
$15,000. She can rent out the 4 apartments (two
bedrooms each) in the building, at $360 per month.
Step 1 of EE Process: Problem recognition, definition,
and evaluation
Step 2 of EE Process: Development of Alternatives:
The following alternatives were available:
(A) Raise the rent.
(B) Lower the maintenance expenses.
(C) Sell the apartment building.
(D) Abandon the building.

Engineering Economic Process with

Application(contd.)
Apply Step 3 of EE: Develop Prospective
Outcomes
Incorporates Principle 2 (Focus on Differences),
Principle 3 (Use a Consistent Viewpoint) and
Principle 4 (Common Unit of Measure)
It also uses the Basic Cash-Flow Approach employed in
EE Represents Economic Effects of an alternative in
terms of money spent and received
In the Case of Your Friend(A) Raise the rent. How much??
To cover the monthly expense of $25,500/12 = $2,125,
the rent has to be $2,125/4 = $531.25 (for each of
the 4 apartments)
i.e. an Increase of $(531.25 360) = $171.25 which is
171.25/360 * 100 = 47.6% increase!

Engineering Economic Process with

Application(contd.)
Apply Step 3 of EE: Develop Prospective Outcomes
(contd.)

(B) Lower the maintenance expenses How

much??
Lower the monthly expenses such that the expenses
are covered by the monthly revenue of $1,440
Present monthly expenditure = $25,500/12 = $2,125
Since annual mortgage payment ($10,500) cannot be
reduced hence only option is to bring down the
monthly maintenance cost of building to a value $C
such that
($10,500/12) + $C = $1,440
i.e. the monthly maintenance cost should be at ($1,440
$10,500/12) = $565 rather than the present
$1500/12 = $1250
This amounts to (565-1250)/1250*100 = 54.8% drop

Engineering Economic Process with

Application(contd.)
Apply Step 3 of EE: Develop Prospective Outcomes
(contd.)

(C) Sell the Apartment Building Approximate

selling price??
The apartment building should be sold at a selling price
which recovers the original $10,000 investment +
the amount that she is losing every month on this
venture during the time it is owned i.e. $8220/12 =
$685 per month
(D) Abandon the Building Can this option be bad
for your friend??
If your friend walks away from the venture, the bank
will most probably take possession through
foreclosure and also try to collect some penalty from
her. Her credit rating would also fall.
i.e. A Very Bad Option!!!

Engineering Economic Process with

Application(contd.)
Apply Step 4 of EE: Select a Decision Criteria
For this step one should incorporate Principle 3 (Use a
Consistent Viewpoint) and Principle 5 (consider all
relevant criteria)
For your friend the criterion to discriminate among the
alternatives could be minimize the expected loss of
money
Another criterion could be credit worthiness
Apply Step 5 of EE: Analysis and Comparison of
Alternatives
For this step Principle 2 (Focus on differences) and
Principle 6 (Make Risk and Uncertainties Explicit)
are important
If your friend considers both minimization of cost and
credit worthiness then Option D (Abandon the

Engineering Economic Process with

Application(contd.)
Apply Step 5 of EE: Analysis and Comparison

of

Alternatives (Contd.)
Option C (Sell the Apartment Building) may also affect
your friends credit rating. Further, there is
uncertainty
regarding
complete
recovery
of
investments (or costs) people may not be willing
to pay higher price than what she had bought it for
depreciation of asset
Thus, options A (Increase Rent) and B (Reduce
Maintenance Costs) may be the only alternatives
worth pursuing..
What if a new Directive is expected in near future from
the local government that each apartment building
should compulsorily have an appropriate security
system installed and maintained by the owner?
This unexpected directive (i.e. future uncertainty)

Engineering Economic Process with

Application(contd.)
Apply Step 6 of EE: Selection of Preferred
Alternative
If the above directive from local government is
impending then the preferred alternative for your
friend would be Option A (Increase Rent)
Your friend may try to do market research of
comparable housing in the area or
Maybe a fresh coat of paint and new carpeting would
make the apartments more appealing to prospective
renters...

Then rent can probably be raised to cover all the cost

and with 100% occupancy of the four apartments.

Engineering Economic Process with

Application(contd.)
Apply Step 7 of EE: Performance Monitoring and
Post evaluation of Results
For this step Principle 7 (Revisit your Decisions) is
relevant.
Your friend decides to offer the apartment at higher
rent Three apartments are occupied by families
However she is not getting tenant for fourth one
she has to search for solution for this.
Maybe she can rent the 4th apartment to two students
on price-sharing basis that can cover the remaining
costs.